Stepping Back: Product, Collections and Credit Risk in PAYGo Solar
As financial services investors who have researched and invested in the off-grid solar industry, we read with great interest Daniel Waldron's blog post on credit risk in pay-as-you-go (PAYGo) solar. While we agree with the post’s argument that PAYGo solar companies can lower delinquency rates by improving their risk management practices, we believe that even more fundamental factors influence repayment rates: namely, product price and quality, and collections approaches and interventions.
Funds managed by Apis Partners have invested in one of the leading global players, Greenlight Planet. By distributing and financing entry-level solar products that provide much needed electrification to off-grid households, companies like Greenlight are helping rural African customers to develop financial identities, credit histories and collateral in the form of the solar device. Rural African households can leverage all of this for follow-on products, such as broader appliance financing, or even value-added financial services, such as education loans or crop insurance — but only if the credit that lenders extend is repaid.
How product quality and price affect repayment rates
When thinking about credit risk in PAYGo solar, it is important for investors to know whether a company’s product provides enough value to customers at its current price. Suboptimal product characteristics can lead customers to stop repaying because they don’t value the product or can’t afford the payment plan.
To maximize repayment rates, PAYGo companies should sell reliable solar home systems that produce sufficient brightness and energy to warrant rural African households prioritizing their PAYGo solar payments over competing cash outflows. They should also match quality with prices that appeal to value-conscious rural African customers.
PAYGo companies can make their products more affordable by focusing on cost at the level of the contract manufacturers. They need to work closely with producers to source raw materials and design products, shaving cents off the production process whenever possible. This is one of the key reasons that Apis Partners decided to invest in Greenlight: a relentless focus on providing well-designed, high-quality, yet low-cost, products for off-grid consumers globally.
Cheaper products produce a virtuous cycle of benefits for PAYGo companies. First, cheaper products have shorter financing tenors, and shorter financing tenors tend to result in higher repayment rates. Higher repayment rates result in a more financeable “loan book,” which can help PAYGo companies attract more funding at a lower cost. All of this leads to faster growth, more sales and greater scale, which, of course, results in scale-buying efficiencies and a lower cost of production. In other words, it becomes easier to offer even cheaper products.
This virtuous cycle helps explain not just repayment rates but the competitive dynamics in East Africa’s PAYGo sector over the past three years. Waldron's post referred to examples of worsening credit quality as some players scaled. In our experience, this holds only when product dynamics have yet to be optimized. Beyond the early adopter cohorts, customers in the mass market will not repay when the product is not useful enough or the payment plan is too onerous.
How collections affect repayment rates
Collections approaches and interventions also directly influence repayment rates. Historically, PAYGo companies have been highly sales-oriented organizations focused on growth. Collections have not necessarily been optimized, which has led to suboptimal and sometimes even worsening portfolio performance. This is starting to change. Increasingly, PAYGo organizations are prioritizing collections, from senior management down to field agents.
One of the most important ways that PAYGo firms are better addressing collections is in tying agents’ compensation more directly to their customers’ unit disabled rates. Previously, agents were known as “sales agents” and were incentivized to focus only on selling units to new customers. As a result, agents paid little attention to whether new customers would repay their loans. With a portion of their overall earnings now tied to collections, agents are much more focused on collections.
Appropriately incentivized agents also have a role to play in helping remote call centers follow up with customers who are behind on their payments. Increasingly, PAYGo firms are using agents instead of call centers to contact customers who are slightly delinquent, with call centers serving a backup or escalation function. Some firms are finding that agents are up to 50 percent more effective at getting customers to make overdue payments within 48 hours, due to customers’ familiarity with the agents.
All told, collection interventions are improving repayment rates and lowering disabled rates, significantly changing credit risk discussions in the PAYGo solar sector. In our experience, however, this does not happen at a PAYGo organization without a clear shift in mindset toward collections. Collections very much need to become part of the DNA of PAYGo organizations.
Back to basics
There is still too much noise and not enough signal in high-level credit risk data on PAYGo solar. If repayment rates are falling, PAYGo companies should re-evaluate their products and collections before assuming that credit risk for poorer customers is unmanageable and moving up-market. It is important to get this right: faulty assumptions can deny electrification and credit to large swathes of vulnerable but responsible customers across rural Africa.
Of course, PAYGo providers still need to improve their credit capabilities, from underwriting to credit risk management, and to develop the organization and systems to properly manage credit risk. In fact, by acquiring customers who are beyond the reach of traditional financial institutions and capturing data on solar device use and repayments, PAYGo companies are uniquely positioned to drive even more sophisticated approaches to credit risk management than are local banks or microfinance institutions. But before they do, PAYGo companies need to have a high-quality, affordable product to sell and an approach to getting their money back.
Asad Naqvi is a managing director at Apis Partners. Ravi Bhatt is part of the investment team at Apis.